On mega mine, Qld Government should avoid taking equity risk for just a return on debt

Financial journalist Trevor Sykes would frequently point out that the problem with lending to highly-leveraged companies is that you can effectively take on equity risk while only receiving a return on debt. The Queensland Government needs to avoid this risk when establishing a new royalties regime for first movers such as Adani in new mining regions. The Australian reports:

A compromise was struck ­between Queensland Premier Annastacia Palaszczuk and her deputy, Jackie Trad, on the deal that will be used as a template to lure other resources companies into the state’s burgeoning ­Galilee and Surat basins and the northwest minerals province.

The Australian understands Adani will be given the cut-price flat rate for up to six years — understood to be several million dollars a year — but it will be eventually required to pay the ­entire amount of deferred royalties owed to taxpayers for coal ­extracted at its proposed Galilee Basin mine.

Adani will have to pay interest on the delayed amount.

The State Government should push for more than a standard interest rate on debt and for as rapid repayment as possible. It should arguably receive an equity-like return in the range of 10 percent or more given the level of risk, including the not insignificant risk of the project eventually falling over and the Government receiving hardly any royalties income at all. Indeed, the head of the QRC Ian Macfarlane notes in the Courier-Mail today that he wants the government to have “some skin in the game.” In which case, I would suggest, the Government should earn an equity return, not just a return on debt.

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6 Responses to On mega mine, Qld Government should avoid taking equity risk for just a return on debt

  1. qldmccarthy says:

    Gene, why would Adani accept an interest rate higher than the market?

    On Fri, 26 May 2017 at 5:08 am, Queensland Economy Watch wrote:

    > Gene Tunny posted: “Financial journalist Trevor Sykes would frequently > point out that the problem with lending to highly-leveraged companies is > that you can effectively take on equity risk while only receiving a return > on debt. The Queensland Government needs to avoid this r” >

    • Gene Tunny says:

      John, good question. Arguably if the market will lend to it, it should borrow the money from the market and pay the royalties. The problem I see is that mining companies will accumulate a debt to the government but make only very small repayments to the government for several years. In the meantime there is a not insignificant risk of the project failing and the government only getting a fraction of the money owed. When considering lending money, governments should always ask why won’t the market lend to a project? Is this more risky than it appears?

  2. White Elephant says:

    We are living in the time of easiest credit, arguably, in history.
    Junk bond indexes trade below 5% yield
    Frontier markets are borrowing at 7% (Pakistan, Turkey etc)
    If this project in Australia cant get funding from the drunkest bond market in history – it is illustrative of the economics of the project

    • Gene Tunny says:

      Thanks for the comment White Elephant. It is very surprising that it can’t get the finance from the market and needs credit from the government instead.

  3. Russell says:

    Gene, I am at a loss to understand how foregoing (some or all) royalties for a fixed time with the expectation of having them paid in the future is considered real debt. Not when the payoff is thousands of jobs and a significant boost to service industries and Whyalla steel mill in the construction phase. The company tax and income tax boost is significant. Ok that is not directly state income but it does boost the state economy and something must flow into state coffers. QLD’s GST cut should increase hopefully. The alternative is nothing, no jobs, no tax income, no royalties and no chance of any other company taking the sovereign risk in invest in that area.
    Real debt is when the government borrows money for a project and other projects/s miss out and there is a real risk of failure and still having to pay back the debt. In this case there is nothing to pay back. I would have thought that failure is unlikely as the customer will be locked in.

    • Gene Tunny says:

      Hello Russell, it looks like debt to me given the company would be charged interest and the company is effectively being extended credit by the government. After all, it could always borrow from the market to help pay its royalties bill rather than the government extending credit. But it seems to be having trouble getting finance from the market suggesting the project is high risk. I accept there could be a case for some concessional treatment if there is other way to guarantee the project proceeds, and then it is really a choice between less than we expected and nothing. But I’m unclear as to what extent this concessional treatment is required and whether it is just a negotiating position from the company.

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